9/9/2010 Ch. 2: The Financial Environment & The Level of Interest Rates C. M. Korth 1 Financial Markets Public markets • Where financial instruments can be bought and resold • Stock markets (equity=ownership) • Debt markets C. M. Korth 2 Money Markets Short--term Short • < 1 year • Debt only C. M. Korth 3 1 9/9/2010 Money--Market Instruments Money Treasury bills (“ (“T T-bills bills”) ”) Certificates of deposit (CDs) CDs) Commercial paper Bankers’ acceptances Money--market mutual funds Money C. M. Korth 4 Capital Markets Medium term & long term • > 1 year Medium & LL-T debt All equity C. M. Korth 5 Capital--market Instruments Capital Notes: 1 1--7 years Bonds: > 7 years Equity • Common stock • Preferred stock C. M. Korth 6 2 9/9/2010 Issuers of Financial Instruments Stocks: Only companies Debt: • Governments Federal (Treasury bonds) Municipal (municipal bonds = “munis “munis”) ”) C. M. Korth • Corporations (corporate bonds) 7 Primary Markets Direct contact between buyer or lender and seller or borrower There is no resale (i.e., secondary) market. C. M. Korth 8 Private Markets Commercial banks Private placements • Venture capital companies • Institutional investors C. M. Korth 9 3 9/9/2010 Public Markets The instruments (stocks, bonds, T-bills, etc) can be resold. • Stock exchanges [= stock markets] • Bond exchanges C. M. Korth 10 Primary Markets 1st time a stock or debt instrument is sold • Initial public offering (IPO IPO) ) • Secondary, tertiary, etc Regulated by Securities Exchange Commission (SEC SEC) ) Investment bankers C. M. Korth 11 Investment Bankers Very different from commercial banks (don’t take deposits) Assist issuer to bring g new issue to market • Paid commissions Flotation C. M. Korth 12 4 9/9/2010 “Best Best--Efforts” Efforts” Flotation Investment bank advises issuer and “floats “floats” ” the new issue. However,, the investment bank does not guarantee the total value of the sale. The issuer does not know what the total proceeds will be. C. M. Korth 13 Underwriting Flotation The investment bank (the underwriter) underwriter ) guarantees the amount that the issuer will receive. receive Actually buys the entire issue at a fixed discounted price. • Commission C. M. Korth 14 Underwriter Takes a lot of risk • Could lose a lot of money, if they can’t can t sell the stocks or bonds at a higher price than they paid the issuer • Or could make a lot of money! C. M. Korth 15 5 9/9/2010 Well--Known Investment Banks Well Goldman Sachs Morgan Stanley C. M. Korth 16 Secondary Markets The market for the resale of marketable stocks and debt = Organized exchanges Also regulated by the SEC C. M. Korth 17 Major Secondary Markets Stock exchanges • NYSE • NASDAQ Bond markets Financial futures & options C. M. Korth 18 6 9/9/2010 Financial Derivatives Markets Future and forward contracts Options and warrants Index contracts Swaps C. M. Korth 19 Market Specialists Brokers: Bring buyers & sellers Brokers: together • Do not own the shares • Charge a commission Dealers:: The “market Dealers “market makers” makers” • Buy for & sell from own account C. M. Korth 20 Foreign Secondary Markets Foreign domestic markets “Off--shore” markets “Off C. M. Korth 21 7 9/9/2010 Financial Environment Summary: The Players Commercial bankers Investment bankers Dealers [the “market makers”] Brokers C. M. Korth 22 Financial Environment Summary: The Regulators For banks: • • • • Federal Reserve C Comptroller t ll off the th Currency C FDIC State regulators For stock & bond markets: Securities Exchange Commission C. M. Korth 23 Financial Environment Summary: Institutional Investors Insurance companies Pension & other retirement funds Mutual funds • 401( k) • Individual retirement accounts (IRAs IRAs) ) 24 8